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July 16, 2010 – Comments (2) | RELATED TICKERS: MSFT

OK, I'm sold. T2 Partners' recent excellent presentation on Microsoft bas caused me to see how this company can easily beat the S&P 500 over the next several years.

Am I a big fan of the Company's use of cash? Absolutely not.

Here's what I had to say on the subject the other day before I had a chance to absorb T2's presentation on the company:

"I have taken a look at Microsoft in the past.  I can certainly understand the logic behind investing in it. The one thing that I don't like about MSFT is the use of its cash, or lack there of.  The Company has zillions of dollars just sitting there and rotting on its books.  There's something to be said for playing it safe and having a decent level of cash on hand, particularly after the scary credit crunch that we just went through.  However, MSFT's cash horde is just sitting there doing nothing.  It significantly hurts shareholder value.  If they can't use the money productively in a reasonable period of time, they should return it to the company's owners in the form of a larger regular, or a special dividend.  Microsoft isn't even using the cash to pay down debt.  It is sitting on billions of dollars in cash and actually issuing new debt.  Here's a great Vitaliy Katsenelson article on the subject, Microsoft Debt Issuance Makes Zero Economic Sense.  

Tuesday’s  headline from the WSJ reads: Microsoft Corp. (MSFT)  to offer u.......”

The software company will use the sales proceeds to repay short-term debt. If it was any other company I’d ignore this headline as a daily noise as this kind of things happens all the time. But Microsoft has $39 billion of cash and generates $16-$17 billion of free cash flows a year. Issuing short-term debt, for which Microsoft will surely pay higher interest than it receives on the pile of its cash makes absolutely no economic sense – zero.

Microsoft has $1 and $0.75 billion of debt that matures in 2019 and 2039, respectively. Ironically, though this debt comes with higher interest, it makes sense if the company believes that we’ll have significant inflation and it will be paying off its debt with inflated dollars.

When you are sitting on pile of cash that earns nothing, borrowing short-term (three years is short-term) makes no economic sense. It seems Microsoft finance department suffers from the same problem many investors do, it cannot sit on its hands, it has to do something even if it is losing proposition for the company and shareholders."  

Microsoft does pay a near-2% dividend, but I think that its return of cash to shareholders should be significantly larger than that. I don't understand why MSFT has any debt at all, given its huge cash horde and massive cash flow.  Perhaps the company will eventually come to its senses and use this cash for something productive.  Doing so would act as a further catalyst for its share price.  

In MSFT we have a company that's currently trading at around 12 times its trailing earnings. Using T2's assumption of $2.40/share in earnings for 2011 and assuming its multiple stays stable we arrive at a price per share of $33, a 31% increase from today's price...not including the dividend.

That's a fairly conservative estimate of where MSFT will be a year and a half from now. Does anyone believe that the S&P 500 will be 31% higher than it is today in 18 months? I certainly don't.  I added MSFT to my CAPS portfolio yesterday at $25.15/share.


2 Comments – Post Your Own

#1) On July 16, 2010 at 2:37 PM, XMFPhila100 (89.59) wrote:

Hi Deej,

Yeah, it's a little odd, but most of MSFT's $39b "cash" is tied up in short-term investments -- about $31 billion of it -- spread across gov't/agency bonds, corporates, foreign gov't bonds, munis, MBSs, etc. All of these investments earn at least a little interest.

In contrast, it's paying essentially nothing on the debt it raised. Can't say I blame them.



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#2) On July 17, 2010 at 8:33 AM, TMFDeej (97.44) wrote:

Good point, Todd.  I haven't looked at Microsoft's bond yields lately.  They aren't actually lower than the yields on Treasuries are they?  If so, then I suppose that the move makes sense.  If not then it's just throwing away money.

Anyhow, people buy MSFT because they sell computer software not because they are some sort of awesome money manager. They need to stick to their knitting.


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